Jan 11, 2021 - Economy

Criticism of the Fed is going mainstream

Federal reserve logo

Illustration: Eniola Odetunde/Axios

Big names in the world of finance are beginning to call out the Fed and other central banks for their role in ramping up economic inequality and manipulating financial markets — a departure from the praise they received for most of last year.

Why it matters: Wall Street was the only pillar of solid support. Most Americans say they don't trust the Fed and politicians look to be taking aim at the central bank for overreaching with its unprecedented actions in March.

Driving the news: Mohamed El-Erian, chief economic adviser at $2.8 trillion asset manager Allianz and the former chair of President Obama's Global Development Council, became the latest heavy hitter from the financial industry to issue a rebuke of central banks' policies.

What he's saying: "There is abundant evidence that the beneficial economic implications are low, and the costs include irresponsible risk-taking, higher inequality, distortion of financial markets such as negative interest rates and misallocation of resources," El-Erian told Switzerland's The Market.

  • "I don’t think central banks quite realize how much irresponsible risk-taking is going on," he added.
  • "In 2010, Ben Bernanke talked about the benefits, costs and risks that come with unconventional policy. He added, the longer you maintain it, the lower the benefits, the higher the costs and risks. This was ten years ago. At that time, Bernanke was thinking of unconventional policy as an economic bridge. Now, it has become a destination."

Zoom in: "We have stumbled into very unhealthy co-dependences; co-dependences between central banks and investors, between central banks and debt issuers which are governments and companies, and between central banks and politicians," El-Erian said.

  • "They are all in this unhealthy co-dependency. It’s like a bad marriage: They’ve ended up relying on each other, and they just don’t know how to get out of it."

Former FDIC chairwoman Sheila Bair was similarly unkind in her assessment of the Fed's actions in a Wall Street Journal editorial last week.

  • "Capitalism doesn’t work unless capital costs something and markets don’t work unless they’re allowed to rise and fall. The corporate facilities may have originally been justified as extraordinary one-off interventions to help companies maintain operations, but they morphed far beyond this purpose, and distorted capital allocation."
  • "The result was a windfall for investors, cheap credit for the uncreditworthy and record-shattering levels of corporate leverage."

Between the lines: Calls for change are even coming from inside the house. Fed presidents, including Atlanta's Raphael Bostic, Boston's Eric Rosengren, San Francisco's Mary Daly and Minneapolis' Neel Kashkari, have all spoken publicly about the Fed's role in worsening inequality.

Keep an eye on the yield curve

Data: U.S. Department of the Treasury; Chart: Andrew Witherspoon/Axios

"One of the most under covered stories is what’s happening to the U.S. yield curve," El-Erian warns.

What's happening: "It’s on a consistent move up, and that puts the Fed in a very difficult position, because if it allows the curve to continue to steepen, it can undermine financial stability," he tells The Market.

  • "If the Fed wants the yield curve to stop steeping, it has to implement yield curve control, or what they like to call yield curve targeting. But yield curve targeting is a huge step in policy."
  • "It would distort the U.S. Treasury market completely. So keep an eye on this, because this is starting to get to dangerous levels."

The big picture: Ultra-low Treasury yields are a major factor underpinning the runup in stocks. Experts have warned that the Fed's new stance encouraging inflation risks letting interest rates get out of control.

Where it stands: The difference between yields on 10-year Treasury notes and 2-year notes jumped to 1%, its highest since July 2017.

Editor's note: A quote from Neel Kashkari to the FT was removed as he was referring to another issue.

Go deeper